On Black’s Leverage Effect in Firms with No Leverage

Abstract

One of the most enduring empirical regularities in equity markets is the inverse relationship between stock prices and volatility. Also known as the leverage effect, this relationship was first documented by Black, who attributed it to the effects of financial or operating leverage. This article documents that firms that had no debt (and thus no financial leverage) from January 1973 to December 2017 exhibit Black’s leverage effect. Moreover, the authors find that the leverage effect of firms in this sample is not driven by operating leverage. On the contrary, in this sample the leverage effect is stronger for firms with low operating leverage as compared to those with high operating leverage. Interestingly, the firms with no debt from the lowest quintile of operating leverage exhibit a leverage effect that is on par with or stronger than that of debt-financed firms.